"You say you want a revolution
Well, you know
We all want to change the world"
Occupy Wall Street:
You know, "Revolution" is an interesting word. On the one hand it conjures up images of heros rising up against tyrants, battling for freedom and change. On the other hand, from a celestial perspective, "Revolution" refers to one complete orbit of a planetary body around its center, as in the earths revolution around the sun. In other words, after one revolution you end up right back where you started.
Same word, two completely different meanings...on the one hand you have change, and on the other you have more of the same. Unfortunately in politics this is usually how things work out. Politicians campaign on the "change" platform, only to end up following the path of those that they replaced. Hence the saying, "The more things change, the more they remain the same."
This is the great weakness in any political system: "Government" is based on the idea that a few people are awarded more power than those they govern. The power to declare war (kill), and the power to confiscate wealth (via theft, taxes, or currency debasement). On an individual level these powers are considered immoral, but they're perfectly acceptable on the governmental level. Oh yes, the government tries to dress it up as "being good for the populace at large", but in the end it comes down to maintaining the status quo and consolidating power.
Our forefathers were very wary of the immoral powers of "government", therefore they went to great lengths defining individual rights, state rights, and limits on national government. Our politicians have subsequently spent the last 235 years marginalizing the rights of individuals, and consolidating power.
I'm not sure exactly what the "Wall Street Occupiers" stand for. Some say they are the antithesis of the "Tea Party", while others say they are kindred spirits.
I totally agree with their outrage over government bailouts of bankers, those who take the risk should reap the rewards and suffer the consequences. But our government stepped in and determined who the winners and losers would be. The people (tax payers) lost, and bankers won.
I totally disagree with the belief that the "government" needs to do more. That they need to confiscate more funds from those that earned them and reallocate them to others. That student loan debt should be forgiven, or that mortgage debt should be forgiven. The individual has to take responsibility for their debts, not the government. This is the moral way.
While advocating "Revolution" may be a noble ideal, make sure the "change" you advocate does more to return power into the moral hands of individuals, versus the increasingly immoral hands of government. The occupation should be in Washington not Wall Street.
End Market Correlation - The Other Revolution:
While not nearly as captivating as "Occupy Wall Street", there is another smaller (but nonetheless important) movement among Wall Street geeks to end (or at least understand) the markets extraordinary high levels of correlation. Right now the level of correlation in the stock markets is at all time highs. In laymen's terms, this means that nearly all stocks move in the same direction (up & down) regardless of their fundamentals. Individual company fundamentals (what security analysts spend their lives analyzing) have been replaced by macro factors.
Now clearly those leading this movement (I hesitate in calling it a revolution) are security analysts whose jobs are most at risk. As a portfolio manager/asset allocator I take a slightly different view of this increased correlation...understanding it and profiting from it.
While many analysts believe that the markets are acting irrationally when all companies move in the same direction, I believe that they are behaving totally rationally. They are moving in unison because they share a common fundamental...whether you're talking about Apple or Consol Energy or Brazil. That common fundamental is when Greece will default, what will happen to the banks, what will happen to the Euro, will it spread to Italy and Spain, will it cause a recession in Europe, will it cause a recession here? Will the Fed do Quantitative Easing 3? Will anything constructive happen in Washington prior to 2013? The macro fundamental is trumping the individual fundamentals. Now there have always been macro factors, but since the 2008 financial crisis we have grown to expect government intervention in our capital markets. The markets are now simply "Risk-on" or "Risk-off".
Government intervention trumps individual company fundamentals. Clearly this is not the capitalism or financial markets we grew up with, but it is the market we have to invest in today. Many investors have simply left the financial markets entirely, while others toil away trying to make sense of it all.
As an active asset allocator my number one job is to make sure my portfolios are properly diversified to generate the highest possible returns at the lowest levels of risk. Obviously this entails understanding risk. Over the last several weeks I've been working on a new way of looking at portfolio diversification that takes into consideration both risk and return, and is much more in tune with our current "Risk-on" "Risk-off" environment.
The old way of looking at diversification generally looked like the chart below. Assets were allocated between stocks and bonds, US and international, and maybe gold and commodities. The thought was broad diversification, and a buy and hold mentality, will see you through any short-term rough patch.
The problem with this philosophy is that it simply does not work in todays world of government manipulated, highly correlated assets. There has to be a better way.
My work has led me to the following "Risk Adjusted Allocation". This is a much more dynamic model. Assets are analyzed by risk factors and correlation. Price momentum is then used to determine the appropriate weight in each asset class at any particular time.
The graph below is divided between Risk-on and Risk-off assets, those assets most correlated with the S&P 500 are in the Risk-on camp, while those least correlated to the S&P 500 are in the Risk-off camp. The horizontal axis displays correlation, while the vertical axis displays returns over the last year. The size of each bubble signifies its current weight in the portfolio. As you can see we are currently in the "Risk-off" camp with 74% of our assets.
After over a month of "Risk-off" behavior, this week saw an abrupt shift to "Risk-on". I am still highly skeptical of this bear-market rally, but if it persists you'll start to see assets gravitate from the Risk-off quadrant to the Risk-on quadrant. Again the goal is to be in harmony with the markets, not to fight them.
The main reason for my skepticism continues to be these two charts, until they show marked improvement I believe we're in a bear market:
Be careful out there, and keep the lights on,
Chris Wiles, CFA
412-260-7917
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This article contains the current opinions of the author but not necessarily those of the Rockhaven Capital Management. The author’s opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
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